Doubts Over Returns Hit Fundraising in China

By Chao Deng

Investors are growing skeptical that private equity in China can keep giving them high returns, and local funds are bearing the brunt of their reluctance to pump in more cash.

The reasons: China’s market for initial public offerings has stalled, making it harder for private-equity firms to cash out of investments, and investors are growing disillusioned with the idea that China’s economy is in line for continued spectacular growth. Growth has already slowed slightly from previous years.

Chinese regulators stopped approving initial public offerings last year, leaving many of the private-equity firms that invested in mainland companies stuck. In China, particularly, private-equity firms tend to sell firms they own through IPOs, rather than through sales to other companies.

“The PE industry needs to focus on creating value for Chinese companies, instead of financial engineering,” said Hua Lin, managing director at Xiamen Venture, a private-equity investor linked to the government of Xiamen, a city in southeast China.

Falling returns reflect the difficulty of cashing in on investments. Last year, the amount that private-equity firms investing in China gave back to their investors fell to $7.1 billion from $10.9 billion in 2011, according to Asia Private Equity Review.

Some Chinese investors who had promised to put more money in yuan-denominated private-equity funds have rescinded their commitments because of weaker returns, people at several private-equity companies with yuan-denominated funds said.

“Especially early in a fund’s life, there isn’t much financial penalty for a default” on a commitment to invest in a fund, said Gary Rieschel, founder of Shanghai-based venture-capital firm Qiming Venture Partners. Qiming, which specializes in dollar funds, raised a small yuan fund last year to diversify its portfolio.

The biggest sources of money for private-equity funds that raise money in yuan are usually wealthy Chinese individuals who are relatively inexperienced in private-equity investing.

These investors often take a more speculative approach than the experienced Western institutional investors that invest in dollar-denominated China funds.

The “immature investor base” makes for “extreme volatility in fundraising and management,” said Mr. Rieschel.

Domestic private-equity firms are finding it harder to raise cash for yuan funds. China-based private-equity firms raised 82.8 billion yuan ($13.3 billion) via 52 yuan-denominated funds last year, down from the 108.3 billion yuan raised via 75 funds in 2011, according to Preqin Ltd., a London-based research firm. This year, there have been only two such new funds, both geared toward real-estate investments.

The two largest yuan funds raised last year by Chinese private-equity firms were a 12 billion yuan fund by Citic Private Equity Funds Management and a 10 billion yuan fund from Haitong Kaiyuan Investment.

Yuan funds raised by foreign companies—a more recent phenomenon— have been smaller.

A yuan fund gives foreign private-equity firms access to more deals, and helps them stay competitive with domestic funds in winning deals. Dollar funds can convert their cash to yuan, but the process takes time, which can be critical in deal-making.

Carlyle Group LP, for example, has two yuan-denominated funds, both of which were announced in 2010. It raised about three billion yuan for a Beijing-based fund and $100 million for a joint-venture yuan fund with Chinese conglomerate Fosun International Ltd. TPG Capital LLP is in the process of raising a 10 billion yuan fund, which it announced in late 2010.

If investors continue to pull back in giving yuan to private-equity funds, Chinese businesses could find it more difficult to secure financing.

“Millions of great private companies are now being completely starved of capital,” said Peter Fuhrman, founder of Shenzhen-based investment-advisory firm China First Capital.

“This is going to have serious consequences for China’s gross domestic product [and] for the switch from a state-owned enterprise-driven to a consumption-driven economy. The stakes couldn’t be higher.”

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